Financial Markets in a State of Flux
Financial markets have been choppy since the November election, and for good reason. With the next presidential administration promising sharp policy changes on a broad range of economic issues, there is plenty to be nervous about.
Uncertainty Abounds
The new proposals are dizzying. The president-elect says he wants to deport millions of immigrants; impose tariffs on all countries, especially China; slash taxes; expand the use of cryptocurrency; eliminate wind-powered electric generation; and increase production of fossil fuels.
It’s impossible to know which policies are fanciful, which will be carried out or what all the economic and market consequences might be. No wonder the markets are confused.
A Glimmer of Hope
Still, if you need solace, most investors need only check their portfolios. If you have held stocks since the end of 2022, when the market picture improved radically, there’s a good chance that your portfolio has had a spectacular performance. All you really needed to do was hold a piece of the broad U.S. stock market in a cheap, diversified index fund. Bond returns have been mediocre, as the final annual numbers on the portfolio performance of ordinary investors reveal, but U.S. equities have paid off handsomely, with annual returns for the S&P 500 of roughly 25% for each of the last two calendar years.
A Word of Caution
While those gaudy returns are comforting – especially after the calamities of 2022, when inflation soared, interest rates rose and both stocks and bonds sank in value – they aren’t predictions. No one knows where the stock, bond and commodity markets will end up when 2025 is over.
History Has a Lesson to Teach
But history suggests a sobering lesson: Stocks and sectors go out of fashion. What worked over the last two years may not work in the next one. Periods of outsize returns are followed by market declines, sooner or later.
Reducing Volatility
I have no idea where the markets are going over the short term. But if you want to reduce the volatility of your investments in the years ahead, I think it’s important to go beyond U.S. stocks and the handful of big tech companies that have been driving domestic returns lately. Hold diversified, fixed-income investments, too, as well as a broad range of international equities.
Recent Returns
After a brief surge from Election Day through Nov. 11, stocks stalled, and for the last three months of the year, the average U.S. domestic stock fund rose less than 1 percent, according to Morningstar, the financial services company. The average actively managed fund lagged the broad, large-capitalization S&P 500 index, which gained 2.3% in the quarter.
Performance in the Quarter
Performance in the quarter was worse for bond funds. Taxable funds lost 2.5% and municipal bond funds lost nearly a percentage point.
The Future is Uncertain
The culprit was rising yields, which have been increasing despite the Federal Reserve’s cuts in short-term interest rates. The bond market’s assessment of the economy – and of the inflation risks posed by the incoming administration’s policies – is less sanguine than the Fed’s. The market sees a strong possibility of sharply rising prices, while there are a range of opinions within the Fed, the central bank overall has judged inflation to be heading downward. Rising bond yields are likely behind the stock market’s stumble, too.
A Word of Caution
When you extend your gaze back to 2024 as a whole, investment returns look better. Domestic stock funds rose 17.3% for the year, though they badly underperformed the S&P 500. BofA Global Research, a unit of Bank of America, found that 64% of actively managed, large capitalization funds failed to beat the market. That underperformance has been occurring regularly for decades, Bank of America found. That poor record is why I rely mainly on broad index funds, which merely try to match market returns.
International Stocks
Most international stock funds didn’t keep up with their U.S. counterparts. They lost 6.7% for the quarter and gained 5.5% for the year.
Risk Taking
For the best returns, you needed to place bets on particular companies or sectors, and be smart or lucky enough to get it right. Investments bathed in the glamour of artificial intelligence were big winners in 2024. Nvidia, which makes chips for A.I., gained 171%. It trailed only two other S&P 500 stocks. One was Palantir Technologies, a military contractor that uses A.I., which returned 340.5%. The other was Vistra, an operator of nuclear power plants that have come into high demand because of the voracious power needs of companies developing A.I.; it rose 258%.
Other Sectors
Funds that concentrated on banks – which could borrow money at low rates last year, because of the Fed, and lend it out at much higher ones, thanks to the bond market – also prospered, with a return of 27.6% for the year.
MicroStrategy and Bitcoin
Then there was MicroStrategy, whose main business is buying and holding Bitcoin. MicroStrategy rose 359% in 2024, a windfall that will evaporate if Bitcoin goes out of fashion, as it did in 2022.
Most People’s Investments
Most people investing for retirement took fewer risks – and reaped lesser rewards – but still had strong returns. Funds with an allocation of 50 to 70% stock, with the remainder in bonds, gained 11.9% for the year on average, Morningstar said. Those with 70 to 85% stock, with the remainder in bonds, rose more than 13%. High-quality bonds pulled down investor returns, but they have historically been safer than stock and are often a balm when the stock market falls.
Remember the ’90s
Tech stocks have bolstered returns before. They were the key to outstanding market performance in the 1990s, the dot-com era. From 1995 through 1998, the S&P 500 gained more than 20% annually, and came close to 20% in 1999, largely on the strength of tech stocks.
A Word of Caution
But the market rose too high, forming a bubble that burst in March 2000. Starting that year, for three consecutive years, stocks had catastrophic losses. If you invested in stocks for the first time in late 1999, your holdings would have been underwater until well into 2006. Returns for an entire decade were disappointing.
Conclusion
By some metrics, stocks aren’t as extravagantly priced today as they were then, but they are high enough to be concerning. As a permanent investor, I’m seeking a solid return over my entire lifetime, and I’m acutely aware that years of gains can be wiped out in a market crash, if you aren’t prepared for trouble.
Frequently Asked Questions
Q: What’s the best way to reduce the volatility of my investments in the years ahead?
A: Consider holding diversified, fixed-income investments, as well as a broad range of international equities.
Q: What’s the best way to prepare for a market correction?
A: Consider rebalancing your portfolio to restore a mix of assets that you can live with, and be prepared for a potential market decline.
Q: What’s the best way to invest in the current market?
A: Consider holding
